RMDS & ROTH CONVERSIONS: TODAY’S SLOTT REPORT MAILBAG

Jan 3, 2019

By Andy Ives, CFP®, AIF®
IRA Analyst

Question:

Hi Mr. Slott:

I turn 70 ½ years old this year (D.O.B. 5-28-49) and must commence RMDs for an IRA total asset value as of 12/31/2018. When do I have to report this RMD on my tax return – before or no later than 4/15/2019? I have all my IRA funds with one custodian. Do they calculate the RMD or do I have to calculate? Also, my spouse has an employer 401a – can she aggregate the employer plan with all her other IRA funds for the RMD and withdraw from one of the IRA accounts, or does she need to segregate these two retirement classes (IRA vs 401a) and withdraw the RMD from each?

Thanks for your help and looking forward hearing from you soon.

Your Friend, Bob

Answer:

Bob,

All excellent questions, but first I want to be sure we are clear on dates: with a D.O.B. of May 28, 2019, you will, of course, turn 70 this year in May. You will turn 70 ½ on Thanksgiving Day, exactly 6 months later. This means that your first RMD is for this year, 2019. The 2019 RMD will be based on your IRA account balance(s) as of December 31, 2018. For your first RMD only, you can take it during the calendar year, or delay it until no later than April 1, 2020. All future RMDs must be withdrawn during the calendar year. If you delay your first RMD, you will be required to take two RMDs next year – one for 2019 and one for 2020.

As for reporting the RMD on your taxes, if you take the 2019 RMD this calendar year, reporting is due when you file your 2019 tax return, which will be April 15, 2020. If you elect to delay your first RMD until 2020 as mentioned above, then both RMDs (2019 & 2020) taken next year will be due on your 2020 tax return, to be filed by April 15, 2021.

Custodians are not required to calculate your RMD, but they are required to give you a number upon request. While many custodians will help with RMD payouts as a matter of customer service, ultimately, it is your responsibility to calculate your own RMD and take the appropriate withdrawal.

Regarding your wife, she can aggregate her IRA account balances and take the total RMD from one of the IRAs. The employer plan is a separate entity and can not be aggregated with the IRAs. It will have its own RMD which must be withdrawn from the employer plan.

Question:

Regarding Roth conversions: How do you explain the pro-rata rule to a client that has $1,000,000 in his traditional IRA and about $25,000 in a non-deductible IRA with a basis of $19,500? He wanted to convert the $25,000, but his accountant advised against it because the pro-rata rule would mean he pays tax again on the bulk of the rollover.

Thanks, David

Answer:

David,

The pro-rata rule will have an effect on the conversion. When a client has both pre-tax and after-tax dollars in an IRA (or across multiple IRAs), they cannot withdraw, or this case convert, only the after-tax dollars. When the conversion is done, we must take into consideration all IRA dollars.

The pro-rata rule states that each dollar withdrawn from the IRA will contain a percentage of tax-free and taxable funds based on the percentage of after-tax funds vs. the entire balance in all IRAs. In this case, the client has roughly $1,005,500 pre-tax dollars and $19,500 after-tax dollars in his IRAs. Based on this ratio, the pro-rata rule dictates that of the $25,000 to be converted, over 98% would be taxable. The client would need to file Form 8606 with his federal income tax return to determine the taxation of the conversion.

The client does not lose the $19,500 basis. It is essentially transferred to the large $1,000,000 traditional IRA.

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